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Falling Canadian dollar will spur inflation, growth: TD Economics

Here’s another benefit of the falling Canadian dollar: it will help inflation pick up again, and that will ultimately be good for the Canadian economy.

Huh? How could inflation, a steady increase in the prices that we pay for goods and services, be good for us?

Food prices have been falling not just because a higher dollar gives greater buying power abroad, but because of so-called grocery store wars, particularly in Ontario, where Wal-Mart and Shoppers, for instance have started selling groceries. Stores have competed by dropping prices to attract customers.
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In short, it’s a sign that the economy is getting stronger.

“Part of what’s going to drive inflation higher over the months ahead is stronger demand,” said Leslie Preston, economist at TD Economics. “It’s not so much that inflation is good, but it is a reflection of a stronger economy.”

Moreover, the opposite of inflation – a state of falling prices known as deflation – is bad. Just ask Japan, which has suffered the affliction for two decades.

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Economists call it the paradox of thrift. If prices are falling broadly in the economy, consumers will put off making purchases. In other words, why would I buy a car today if I think it’s going to cost $2,000 less in six months or a year from now?

“Consumption is one of the things that drives economic growth,” Preston said. “When you get an environment of falling prices, people delay consumption decisions because it will be cheaper in a few months. That slows economic growth.”

The Canadian economy hasn’t seen widespread instances of falling prices, or deflation.

But the annual rate of inflation has been tiny. It stood at just 0.7 per cent as of October, far below the Bank of Canada’s 2 per cent target. The central bank, and its governor Stephen Poloz, are paying close attention.

The worry is that when inflation is this low, the greater the odds that a big shock to the economy could send it into deflation territory.

There are several forces at work keeping a lid on inflation, TD Economics explained in a report released Thursday.

Food prices, for instances, have been kept in check by both the stronger buying power of the Canadian dollar, and fierce competition among retailers, particularly in Ontario, where the arrival of big U.S. retailer Target had incumbents Metro, Loblaws, and even Wal-Mart cutting prices to hang on to market share.

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“It’s been great for consumers but hard on margins in the industry,” Preston said.

As well, health care costs have fallen as some of the most widely prescribed drugs in Canada came off patent – generic versions of cholesterol cutting drug Lipitor are now available for 80 per cent less, TD pointed out.

Lower prices for gasoline, clothing and technology have also helped take the wind out of the sales of inflation.

Now the grocery store wars are easing, and the economy is expected to pick up, driving up demand, and pulling inflation along with it.

The falling Canadian dollar, which will reduce our buying power, will add to that upward pressure. TD expects the Canadian dollar to fall below 90 cents U.S. and stay there until the end of 2015.

Welcome back, inflation. But don’t worry. TD doesn’t expect any sudden spikes. “Inflation’s upward march should be very gradual. Indeed it may be late 2015 or early 2016 before the Bank of Canada’s core measure of inflation reaches the 2 per cent target,” the bank said in its report.

Predictable, stable inflation is good for business, Preston said. That way, “Businesses can say, ‘We expect price increases to be roughly 2 per cent over the medium term,’ and they can set contracts and wages accordingly.”

By the way, here’s another drawback of deflation – it makes your debt larger. Consider the reverse. If you have a $300,000 mortgage at 4 per cent interest, and inflation is running at 3 per cent, “that mortgage is getting shrunk every year by inflation,” Preston said. “When there’s deflation, your debts are essentially getting bigger. The value of those debts in real terms is going up.”

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